Frustration of contracts and creative thinking31 Mar 2020 // Insights
Head of Property Dispute Resolution, Leon Golstein, discusses the Doctrine of Frustration.
Whilst we are very early into the lock-down afflicting the nation and its economy, people are already looking for legal ways to modify or escape contractual obligations to others, on grounds that an unprecedented change in the legal and commercial landscape which has so fundamentally changed their plans,businesses, and profits, must necessarily give them a legal out. The question is whether the law will provide such a remedy.
The below is a short explanation for those seeking general information on the Doctrine of Frustration. The subject is complex and the case law extensive, and as such, this note cannot be a comprehensive review of the subject matter. Specific situations call for specialist advice on a case by case basis.
The Doctrine of Frustration was developed in the English Courts from the mid-18th century, to balance the inequities of an unforgiving legal framework in which contracting parties were always held strictly to their undertakings and obligations, irrespective of circumstances which impacted their capacity to deliver. The judicial view at the time was that if the Courts could not be trusted to uphold a bargain, respect for English law and British commerce across the globe would be irreparably undermined.
From the mid-1800’s, the common law evolved to give Judges a rare power, in exceptional circumstances, to declare a contractual relationship frustrated, which means void, nugatory, and over. For the doctrine to apply, a change had to affect the very heart of the bargain and core circumstances under-pinning the deal, and be so fundamental in nature as to render performance impossible. The change had to be from an external force, could not pre-date the agreement, could not be foreseeable, and neither party could be even partly blameworthy.
That threshold remains a hard one to reach. The change of circumstance cannot be temporary, nor will it matter that the change brings exceptional hardship, making it harder or punitively costly to deliver, and perhaps even removing all profit from the deal.
Several case examples shed light on this. The submarine threat to commercial shipping during the war was not a frustrating circumstance because it did not prevent delivery through other means or routes, but added only layers of complexity, security, and expense for the supplier to overcome. A contract to pick up engineering goods from a foreign port that was extensively delayed by local strike action was not a frustrating circumstance, even though it ruined the rest of the shippers delivery schedule. However, an obligation to collect fresh market produce from a foreign port before it perished was frustrated by the closure of the ports of entry by a foreign government because there was no way to dock in time, or at all.
A concert is not frustrated by the loss of one or more key performers, but would be as a result of the death of the only performer, and a performance contract was held to be frustrated when the venue burned down and no alternative venue could be found in time. The requisitioning of property by the military during wartime frustrated short term tenancies and licences, where the army deprived the occupiers of their use for all of their term bit not for lease owners, as the Courts concluded that an interest in land had its own intrinsic value, going beyond mere occupancy. Those decisions led to legislation enabling those affected to claim compensation.
There are many decided cases, but each case turns on its facts, and interestingly on the wording of a contract, and the heart of the bargain. Materially relevant to the present situation, death and incapacity may not always be a frustrating event, because contractual duties can often survive death and devolve to the deceased’s estate. The loss of a linked sale, a mortgage, or a job is financially challenging, but not enough to frustrate a contract to buy or take a lease, unless the contract so provides.
This look at frustration has sudden poignancy to the survival of trade in both the commercial and residential property sectors. In this new world, any client hoping to sell, buy, or lease should have their lawyer insert carefully crafted escape clauses which enables an affected party to pull out, free of cost, or at least on fairer terms than the loss of 10% deposit. According to a realtor, such clauses have already now standard in New York.
Difficulty lies in creating escape clauses that are specific enough to work properly, but not too wide to undermine the very transaction. It is imperative to have an objective and unambiguous method to determine when the condition applies: what if (for example) it were not the contracting party (or their company), but a spouse, child, or primary family funder who succumbs to coronavirus? Many will hopefully recover after two weeks, so when precisely, is the frustration clause to take effect?
An unparalleled change in circumstance is often a catalyst for change and a radical rethink in any society. The tenant market was already pushing back against longer commercial leases, costly capital start-up commitments, and heavy exit costs before this. When the world finally returns to normality, commercial landlords may find that this global event has actually caused a seismic change in the attitudes of the commercial market. This could mean financially weaker businesses, personal capital in much shorter supply, and risk averse tenants who will be far less willing to sign up to large commitments.
Some predict an exponential growth in serviced offices ahead, and that already popular commodity may now spread to retail spaces before long. For property lawyers, perhaps the market is not so bleak after all. Perhaps the time has come for lawyers to persuade landlords to trial more novel and creative solutions, a more thoughtful approach, with greater concessions and more balancing of risk between parties.
Allowing people to bail out in a COVID-19 emergency is only one way to entice nervous buyers back into the market when finances have already been damaged for years to come. Traditional favourites like personal rent guarantees, and upwards only rent reviews will continue to exit, but only if one can find a market to bear them.
Innovative landlords could benefit from this. An example to consider is; a large down payment of 70% of true value at the point of transfer, and staged payments to cover off the balance out of income with a long stop date. Another attractive option for a tenant or a purchaser struggling to get back on their feet may be a lower opening price with an assignable overage style provision to recover a balance, with a bonus element payable in the event of a profitable future sale.
For those who rent, there may be a new market emerging for shorter rolling tenancy terms of six or nine months at larger rents than before, and possibly fully paid in advance, but with the attraction of no terminal dilapidations liabilities on quitting, and longer terms for those who are willing to take them, but with a break clause every year, and voluntary rent reviews up or down for those wishing to stay.
There is scope here for a whole new legal market, but do be wary whilst the law catches up with this new world. Whilst deferred premiums are lawful, the law has not yet changed to adopt grossly excessive deposits, and other type of punitive payments and penalties for non-compliance, which might still fall foul of consumer laws and general law prohibiting the recovery of unjust penalties, and unlicenced and unregulated credit agreements.
Should you have any questions regarding the above information, or need any property disputes related legal advice, please get in contact with Seddons’ Head of Property Disputes, Leon Golstein, at email@example.com.